Terry Faulkner, chairman of the NAPF, opened the conference by recalling that over 2004 we have seen pension scheme trustees being perceived as potential ‘deal breakers’, and corporations increasingly facing the need to manage risk and modernise their benefit arrangements. Terry hoped that the Pensions Bill would act as a catalyst for the design of pension schemes that will meet the future demands of the modern workplace.

Lord Matthew Oakeshott, Liberal Democrat pensions spokesman, then gave the audience an insight into some of the issues that had been discussed during the evolution of the Pensions Bill, and his hopes for the future of pensions provision.

30th NAPF annual survey

The rate of closure of final salary pension schemes has fallen. 10% of final salary schemes have been closed to new members in the past 12 months compared to 26% in 2003.

71% of private sector schemes have increased the employer contributions in order to address funding pressures and 41% have increased employee contributions.

The average long-term funding costs for private sector employers with final salary pension schemes is 16.1% of pensionable earnings this year. This compares to 7.6% for defined contribution schemes.

Managing legacy and dealing with change

Michaela Barry (Sacker & Partners) considered the issues that companies and trustees need to think about when considering the impact of pension scheme closure. Employers need to get advice before taking action, and need to avoid the ‘eel-trap’, whereby a wind-up is triggered easily that, once started, cannot be stopped. Both the employer and the trustees need to check the trust deed and rules carefully and consider the impact of actions taken on the balance of powers. If the scheme closes but is run as a closed fund, the trustees need to have an end-game strategy.

Colin Singer (Watson Wyatt) considered the trend from defined benefit to defined contribution pension arrangements. Employer contributions to defined benefit schemes are typically much higher than they are to defined contribution schemes. There is also a big transfer of risk from the employer to the employees. The closure of defined benefit schemes to new entrants would have an impact on future job mobility as older people may not be able to gain enough of a salary increase on moving to offset the negative impact on their pension benefits. Mervyn Walker (British Airways pensions) gave a personal perspective on the people issues arising from the British Airways pension schemes. British Airways has two legacy defined benefit pension schemes, and a defined contribution scheme for new entrants. The decision to move to defined contribution was taken during 2001–2002. The reason for the change was concern over rising costs, the risks and volatilities inherent with defined benefit pension schemes, and for competitive reasons. British Airways has also been discussing pension issues with its defined benefit pension scheme members, in order to try and agree revised accrual and contributions. These discussions, mainly through trade unions, have so far been unsuccessful. Employees see pensions as ‘important’, ‘complex’, ‘confusing’, ‘boring’, but most of all, ‘the company’s problem’.

Pension schemes and corporate activity

John Moulton (Alchemy Partners) started the presentation by explaining that people are becoming increasingly concerned over the assumptions to make regarding improvements in life expectancy of pension scheme members. But the biggest assumption people make relates to the company’s longevity – for example that it will last for say 30–40 years.

The Pensions Bill originally proposed that pension fund liability would extend to all companies in a group, to directors and their families, as well as to major shareholders. ‘Clearance procedures’ will be used to provide assurance to companies that corporate activity will not be deemed to have been taken to avoid pension scheme liabilities. Mr Moulton questioned whether the Department for Work and Pensions (DWP) would be able to hire staff of the appropriate calibre to deal with the volumes of requests for clearance statements that it will receive. Ian Sykes (KPMG) explained that pension schemes are a form of corporate debt. The amount of the debt is unclear, as are the repayments of the debt. And the ‘moral hazard’ clauses designed to stop companies dumping pension scheme liabilities on the Pensions Protection Fund mean that the debt is not capped by limited liability. The regulator has the power to close loopholes as they arise. So corporate transactions involving pension schemes are risky.

FRS17 represents a ‘best estimate’ and so there is a 50% chance of a deficit calculation being too low. Pension schemes offer a range of options that can be exercised against the employer, but the cost of providing these is not fully reflected in FRS17’s ‘best estimate’. There are also reinvestment risks and longevity risks that are not fully allowed for. Many consultancies are now advocating the use of a solvency valuation in corporate deals.

The message to sellers is to ‘be open’ – buyers will spot pension scheme problems anyway. In addition, they should accept a fair-value approach to pricing and consult the trustees on what sort of deal they are willing to accept. Sellers should also avoid placing arbitrary constraints on purchasers.

Managing risk

Alan Rubenstein (Morgan Stanley) presented a framework called ERM, or enterprise risk management, that allows users to consider the interaction of risks on the balance sheet. Pension scheme deficits are only one source of risk. By identifying risks and assessing the impact, the idea is that controls and monitoring processes can then be put in place to mitigate risks. In some companies, pension deficits represent a high proportion of the market capitalisation. Effective management of the pension scheme assets can have a big impact on risk.

Investment for tomorrow

The conference finished with a lively panel debate, looking at where funds should be invested and who should provide investment advice to trustees. The view was that while actuaries provide a good starting point for seeking investment advice for pension funds, other advisers also have knowledge and ideas suitable for pension fund investment and so trustees may find it beneficial to involve more than one adviser to help with their decision-making process.